Revenue Management

As shown in Figure 9.15, the subject hotel in this illustration contributes 10.7 percent of the total rooms available to sell (230 rooms/2,147 total rooms  10.7%). This ratio is calculated as: Available rooms subject hotel Available rooms comp set 1including subject hotel2 5 Supply share 1%2 Similar calculations are undertaken to compute the subject hotel’s demand and revenue generation displayed in Figure 9.14: Rooms sold by subject hotel Rooms sold by comp set 1including subject hotel2 5 Demand share 1%2 Rooms revenue generated by subject hotel Rooms revenue generated by comp set 1including subject hotel2 5 Revenue share 1%2 RMs analyzing this portion of a monthly performance report (STR includes this specifi c report as part of their “Monthly STAR Summary”) could encounter a variety of possible outcomes, each of which may be helpful in evaluating the hotel’s revenue optimization performance. A close examination of Figure 9.14 reveals six key observations: 1. In January the subject hotel contributed 10.7 percent of the comp set’s total rooms available to sell, captured 10.7 percent of demand (rooms sold) and achieved 10.7 percent of the comp set’s total revenue. In many ways, this could be considered average, or expected performance if indeed the subject hotel was of average quality within its comp set. If, however, the hotel property could reasonably be considered as above average (e.g. superior brand, new property, extraordinary service features, or location), then the performance could be considered disappointing. For a hotel fl ying a less prestigious fl ag or with below average service or property features, however, this performance could be considered quite good. Figure 9.15 Supply Data Property Number of Available Rooms % of Available Rooms (Supply) Subject Hotel 230 10.7 Comp Set member # 1 185 8.6 Comp Set member # 2 280 13.0 Comp Set member # 3 462 21.5 Comp Set member # 4 470 21.9 Comp Set member # 5 520 24.2 Total 2,147 1.0 MARKET SHARE ANALYSIS 333

334 CHAPTER 9 EVALUATION OF REVENUE MANAGEMENT EFFORTS IN LODGING 2. In February the subject hotel contributed 10.7 percent of the comp set’s total rooms available to sell, captured 11.5 percent of demand (rooms sold), but achieved only 9.0 percent of the comp set’s total revenue. In this scenario, the hotel is not achieving its fair share of the revenue generated by the comp set, despite the fact that the number of rooms sold is more than in keeping with its share of supply. This is not a good situation both because room rates are depressed and because of the direct costs associated with selling “too many” rooms relative to the revenue generated. In this scenario, strong consideration should be given to reducing room discounts and/or raising rack room rates. 3. In March the subject hotel contributed 10.7 percent of the comp set’s total rooms available to sell, captured 9.0 percent of demand (room sales) and achieved 11.5 percent of the comp set’s total revenue. This set of results indicates aggressiveness in increasing or maintaining higher room rates, despite a depressing effect on the property’s occupancy levels. This may be a very good situation because higher room rates help increase guests’ perceptions of quality and because the direct costs associated with selling excess rooms relative to the revenue generated by the hotel are avoided. In this scenario, strong consideration should be given to increasing marketing efforts. 4. In April the subject hotel contributed 10.7 percent of the comp set’s total rooms available to sell, captured only 8.5 percent of demand (room sales), and achieved only 8.5 percent of the comp set’s total revenue. This diffi cult and unfortunate scenario could indicate a below comp set average property (e.g., inferior brand, older property, poor service, or quality levels). If the property is truly competitive, however, it indicates a too low room rate structure and ineffective marketing and/or servicing of current guests. 5. In May the subject hotel contributed 10.7 percent of the comp set’s total rooms available to sell, captured 11.5 percent of demand (room sales) and achieved 11.5 percent of the comp set’s total revenue. In this ideal scenario, the subject hotel leads the comp set in room sales and revenue generation. RMs encountering this very desirable circumstance can examine their opportunity to reduce discount rate offerings even further, increase selected rates (especially to less cost-sensitive guests) and work to ensure continued high levels of guest satisfaction. Note: A realistic reassessment of the composition of the competitive set may be in order if this performance level remains consistent. This would be done to ensure that the comp set has not been chosen, either intentionally or unintentionally, to artifi cially infl ate the perceived performance of the subject property. 6. In June, the subject hotel contributed 11.7 percent of the comp set’s total rooms available to sell, captured 11.5 percent of demand (room sales) and achieved 11.5 percent of the comp set’s total revenue. The results of this month illustrate the importance of monitoring supply as well as demand and revenue. When a hotel’s supply contribution changes, it is likely its demand and revenue performance will change as well. In this case, the subject hotel’s market share increased, which could be the result of its adding more rooms, the closing of a competitor, or the offering of a reduced number of rooms (due to renovation) by one or more competitors. In scenarios such as this one, both demand and revenue results must be evaluated

in light of the variation observed in the subject hotel’s supply contribution. In this case, the property’s demand and revenue generation were equal to the prior month (May). However, because of its larger supply proportion, this would represent disappointing demand and revenue results because they are unchanged from those experienced in April. ADDITIONAL ASSESSMENTS A recurring theme of this book is that maximized revenue generation, by itself, is not the best measure of an RM team’s effectiveness. As a result, while a continual assessment of occupancy, ADR, RevPAR, competitive set performance, market share and, if the data are available, GOPPAR and fl ow-through is important, at least three additional revenue-related areas of assessment are also important. These areas of examination and the specifi c questions they can answer are: Source of business: Who are our buyers? Distribution channels: At what cost do our buyers purchase from us? Web 2.0: What do our buyers say about their experiences with us? For some RMs, the answers to these questions may be provided by an effective hotel sales and marketing department or the property’s GM. This is so because the answers to these type questions are critical to effective hotel sales and operations, as well as to revenue optimization. The correct responses to these questions, however, are just as critical to revenue management teams because the answer to the question, “Who are our buyers?” will provide data essential to initial differential pricing decision making. Knowing the distribution channels that deliver the majority of a hotel’s rooms buyers and the costs of those channels is key to effectively opening and closing room discounts and to rooms inventory allocation. Also, better understanding guests’ experiences during their stay can help an RM provide valuable assistance in product improvement, as well as in identifying areas in which a hotel excels and thus could gain marketing and perhaps pricing advantages. Source of Business Assessment In many hotels, answering the question, “Who are our customers?” falls to the sales and marketing department. As a result, fortunate RMs may be provided with detailed information about the proportion of a hotel’s guests who are defi ned as transient, corporate, government, SMERF, other group, contract, or any of a number of alternative designations designed to assist in the selling of hotel rooms and services. Those RMs working in environments in which answers to the question “Who are our buyers?” are not routinely provided to them can make use of a number of excellent hospitality-specifi c marketing management resources that can help them answer it.5 Essential RM Term SMERF: Acronym used to describe Social, Military, Educational, Religious, and Fraternal buyers of hotel rooms and services. Some hoteliers prefer to use the term Sports as oppose to Social when identifying their market mix. The European term in use is often MICE (Meeting, Incentive, Conference, and Event). ADDITIONAL ASSESSMENTS 335

336 CHAPTER 9 EVALUATION OF REVENUE MANAGEMENT EFFORTS IN LODGING For RMs, the assessment and evaluation of sources of business are important for improved decision making. This is so because the marketing mix achieved by a hotel directly affects its revenue-generation ability and its profitability. Experienced RMs know a simple fact: All customers are not created equally. The truth is that some customers are a good deal more desirable (worth more) than others. To illustrate, consider the value to a hotel of two different pieces of business, each staying two nights, each paying the same room rate of $199.99 per night and buying the same number of rooms (200 total room nights); but with very different nonrooms or ancillary revenue expenditures. In this example, attendees at a convention held by the Veterans of Foreign Wars (VFW) spend very differently than do equal numbers of leisure travelers. In Figure 9.16, the revenue variance between these two groups is 32 percent. The variance is calculated as: $57,798 1VFW revenue2 2 $43,798 1Transient revenue2 $43,798 5 Revenue variance or $14,000 $43,798 5 32% revenue variance Group VFW Convention Leisure Traveler Nightly rooms sold 100 100 ADR $ 199.99 $ 199.99 Total room nights (2-night stay) 200 200 Total revenue @ ADR  $199.99 $ 39,998 $ 39,998 Daily per room ancillary revenue $ 89.00 $ 19.00 Total ancillary revenue (Daily ancillary x 200) $17,800 $ 380.00 Total Revenue 2-night stay $ 57,798 $ 43,798 RevPOR $ 288.99 $ 218.99 Revenue Variance 1 32% Figure 9.16 Guest Revenue Contribution Calculation Essential RM Term Marketing mix: The relative proportion of revenue contributed by each of a hotel’s most important guest types (e.g., transient, group, or contract guests). Essential RM Term Ancillary revenue: Nonrooms income. Examples include guests’s food and beverage purchases, meeting room rental, AV-related income, parking, spa charges, and activity fees. Also known as nonrooms revenue.

In this example, it is easy to see that 200 VFW convention rooms are simply more valuable to the hotel’s revenue optimization efforts than are 200 transient rooms even though the rooms are sold at the same room rate. The importance of knowing the relative value of your guests is clear. In fact, frequent traveler or similar guest-rewards programs work mainly because they are designed to let customers know they are more valued than the average guest. Hotel companies know that the value of guests increase as they spend more and as they spend more often, and these type guests should be rewarded or treated in other special ways. RMs must be able to recognize all of their most valuable customers. RMs must also understand the value of their current customers and, just as importantly, they must be able to assess the potential value of future customers. Figure 9.16 also demonstrates the signifi - cant limitations RMs would encounter if they used only ADR, rooms sold (occupancy), or RevPAR generation as the primary means of guest value assessment. Note that in such a limited assessment, both customer types in this illustration would, erroneously, be considered equal in value. In addition to decisions related to rate determination (higher valued guests may be deserving of reduced room rates to encourage their continued business), RMs must understand the source and value of their guests if they hope to implement other revenue optimization strategies. To illustrate, consider Mitch and Sonia, two RMs whose hotels compete in the same market and routinely offer government workers a $99.00 room rate and corporate guests a $149.00 room rate. Assume that Mitch elects, during the Thanksgiving holidays, to offer a 20 percent discount on his corporate travel rate. Sonia’s RM team is considering the wisdom of offering a matching rate. Prior to doing so, it is critical that Sonia’s team understand well the proportion of rooms they sell to this specifi c group. If Sonia’s hotel generates 5 percent of her total room revenue from corporate travelers, the impact of this rate-management decision will be very different than if corporate travelers typically contribute 75 percent of her hotel’s total revenue. Those hospitality professionals with a foodservices background will recognize the similarity of this particular rooms-related challenge to the menu mix challenges they routinely face. This will be examined in Chapter 10. In a hotel, raising room rates signifi cantly on insignifi cantly small sources of business will likely result in minimal revenue increases. Even minimal rate reductions or increases, however, for signifi cantly large sources of business, can result in signifi cantly increased or reduced total revenues. Distribution Channel Assessment Historically, the most common approach to the quality assessment of alternative distribution channels has been related to total revenue generation. The widely shared belief was that those distribution channels that contribute the most revenue volume (Room rate Rooms sold) were considered best. Increasingly, RMs understand that it is total revenue generation less channel distribution costs that characterizes a high-quality distribution channel. This is illustrated well by the advertisement for seminars and training offered by industry professionals specializing in revenue management. One popular revenue management consultant advertised one of her new Webcast seminars with the following headline: ADDITIONAL ASSESSMENTS 337

338 CHAPTER 9 EVALUATION OF REVENUE MANAGEMENT EFFORTS IN LODGING Distribution Management RevPAR is no longer the only metric. Revenue managers now must manage distribution channels based on the cost of reservation in order to achieve maximum revenue “fl ow-through.”6 In Chapter 4 you learned that net ADR yield is the actual revenue realized by a hotel after subtracting the cost of fees and assessments associated with revenue generated by a specifi c. These “reservation costs” can, of course, be signifi cant. You also learned that net ADR yield is a concept useful in determining differential price points and in managing pricing in such a manner as to move repeat buyers from higher cost to lower cost channels of distribution. Recall that the formula for net ADR yield is: Net room rate Standard ADR 5 Net ADR yield In this formula; Standard ADRDistribution channel costs  Net room rate An effective assessment of alternative distribution channels requires RMs to again apply the net ADR yield concept. Figure 9.17 shows a typical variation from the average (mean) distribution channel performance that can occur when distribution channels with differing net ADR yields contribute to a hotel’s total revenues. As shown in Figure 9.17, even when the number of rooms sold and the rate at which they area sold is identical, variation in the cost of the channel can result in above or below average net revenue. To objectively assess the quality of a distribution channel, RMs must consider the standard ADR achieved in it, as well as the total number of rooms sold. They must also, however, carefully assess the channel’s relative cost (Net ADR Yield) if they are to make informed revenue management-related decisions about its continued use. Source Net ADR Yield Rate Net Per Room Rooms Sold Net Revenue 1/2 Average Channel 1 98% $ 299.99 $ 293.99 100 $ 29,399 10% Channel 2 95% $ 299.99 $ 284.99 100 $ 28,499 6% Channel 3 90% $ 299.99 $ 269.99 100 $ 26,999 1% Channel 4 88% $ 299.99 $ 263.99 100 $ 26,399 1% Channel 5 85% $ 299.99 $ 254.99 100 $ 25,499 5% Channel 6 80% $ 299.99 $ 239.99 100 $ 23,999 10% Total 600 $ 160,795 Average 89% $ 299.99 $ 267.99 100 $ 26,799 0% Figure 9.17 Variation from the Average (mean) Distribution Channel Performance

Monitoring Web 2.0 Increasingly, potential guests seek information and make decisions about the hotels they will frequent via Internet user postings. As a result, RMs understand that they have an increasingly important role to play in closely monitoring travel social media sites like TripAdvisor and others like it that post travel reviews. In the 1940s, the fl amboyant and controversial fi lm actor Errol Flynn observed: “It isn’t what they say about you, it’s what they whisper.”7 Today, the Internet allows customers to whisper (or text and twitter!) about your hotel to millions of readers at a time. Although few people actually enjoy criticism, especially when it is unfairly delivered, good or bad comments from guests provide valuable information you can use to improve your product and services. It is important to recognize that you cannot manage or control social media content. You can, however, carefully monitor it. One easy way to do so is to set up a free Google Alerts account for your property (www.google.com/alerts). Tools such as this one search news, blogs, videofi le sharing sites, and others for your hotel’s name and then notify you (via e-mail) of the search results. TripAdvisor can set up a similar program to notify you of any comments about your property that have been posted on their site. Although it is important to monitor and respond to negative comments (see Chapter 8), it is also important to recognize that the majority of comments posted on social media sites are actually positive, not negative. For that reason, it makes sense to carefully monitor social media sites for positive posting about your property. These performance observations, obtained with the permission of the individuals posting the comment, can be posted on your own web site in the Information related to a hotel’s market performance is typically provided by STR, a hotel’s franchise company, and its own marketing intelligence information. TravelCLICK is another excellent source. TravelCLICK helps RMs by providing data regarding e-booking sources. Information supplied by their Hotelligence program helps RMs analyze competitive rates, target desirable travel agents and GDS sources, analyze the impact of their revenue optimization decisions, and create action plans for future months. To learn more about TravelCLICK you can review its web site at www.travelclick. net Since individual travelers and travel professionals increasingly utilize the Internet to book rooms, RMs must make strategic decisions about partnering with and supporting specifi c GDS companies and individual travel-related web sites. TravelCLICK carefully monitors and reports on these popular distribution channels.  RM ON THE WEB 9.2 ADDITIONAL ASSESSMENTS 339

340 CHAPTER 9 EVALUATION OF REVENUE MANAGEMENT EFFORTS IN LODGING Savvy RMs increasingly rely on the Internet to better understand their customers’ attitudes toward their hotel stays. One tactic that is gaining in popularity is that of replacing paper and pencil guest satisfaction surveys with Web-based surveys. In a Web-based survey system, hotel guests are sent an e-mail at the conclusion of their stay asking them to comment about the quality of their hotel room, performance of the hotel’s staff, and their overall feelings about price paid versus value received. After the guest completes the survey, the data go directly into the hotel’s customer experience management system, allowing properties to track guest satisfaction and identify any problem areas that need to be addressed. Medallia is an industry leader in providing hoteliers web-based customer survey assistance and industry tracking data. You can view its web site at www.medallia.com Hotels now utilizing Web-based customer survey systems report increased response rates, respondent-friendly surveys that are easier to complete, signifi cant cost savings, and much faster guest feedback.  RM ON THE WEB 9.3 For RMs working in the lodging industry, a continual evaluation of evolving revenue optimization strategies, tactics, and results is crucial. Revenue optimization techniques in the industry have advanced far beyond a simplistic “head-in-beds” approach that focused on maximizing a property’s occupancy percentage. Such an approach all too often caused RMs to reduce their room rates in the false belief that doing so would increase demand and, as a result, maximize RevPAR. As you have learned, today’s best practices require RMs to establish differential room rates based on market segment acceptance; consider historic, current, and future demand; and manage room rates to refl ect room supply and occupancy demand. Knowledge of pricing theory and understanding consumer perceptions of value are also of great importance to an RM’s success. Increasingly, the integration of profit maximization based on GOPPAR and flowthrough assessment require RMs to consider opening and closing rate codes based on COMMON-SENSE REVENUE OPTIMIZATION form of a testimonial list. Multiple positive comments such as these can have signifi cant power with rooms buyers for the very reason that they are user generated, not property supplied.

the level of profitability associated with each of a hotel’s market segments. Doing so requires that RMs know their hotel’s true costs of sales and that they accept increased responsibility for bottom-line profi tability. Regardless of their job title or their personal impact on their hotels’ departmental operations, however, RMs must ultimately establish their room rates based on their customers’ perceptions of value received for price paid. Experienced RMs know that room rates, because they are prices, set their guest’s initial expectations for their hotels’ products and services. Rates that are too high set unrealistic guest expectations. Rates that are too low undervalue the efforts of the hotel’s staff and deprive the property of deserved profi ts. An overemphasis on Internet intermediaries (who seek their own revenue optimization strategies) as a hotel’s primary selling tool risks product and brand commoditization and in too many cases has led to lack of pricing credibility. What is needed, of course, is a common-sense approach to room rate determination. While common sense is much too often uncommon, RMs would do well to recall the defi nition of common sense proposed by author (of Uncle Tom’s Cabin) Harriet Beecher Stowe’s son C. E. Stowe, who observed: “Common sense is the knack of seeing things as they are, and doing things as they ought to be done.”8 RMs should be those hospitality industry leaders who see things as they are and ensure things are done as they ought to be done. Those RMs in lodging who possess good amounts of common sense know that to do the right things they must: Understand the importance of accurate data when forecasting based upon historical, current, and future room demand. Recognize the impact of current guest demand or pace on rooms pricing. Carefully assess the impact of their pricing decisions on future guest demand and long-term guest loyalty. Avoid pricing practices that lead to the commoditization of rooms; the lodging industry’s primary product. Take into account the impact of their revenue optimization decisions on each of their property’s: Transient markets Group markets Contracted rooms markets Consider all aspects of overbooking before applying it as an effective rooms inventory management strategy. Utilize sound and creative discounting and stay restrictions as supplements to differential rooms pricing strategies. Implement and regularly measure the effectiveness and costs related to their nonelectronic distribution channel management strategies. Implement and regularly measure the effectiveness and costs related their electronic distribution channel management strategies including the: COMMON-SENSE REVENUE OPTIMIZATION 341

CRS GDS IDS Monitor guest experiences using Web 2.0. Calculate and analyze the statistics necessary to assess the RM team’s decisionmaking effectiveness, including: ADR Occupancy RevPAR (limited-service hotel) or Total RevPAR (full-service hotel) RevPOR GOPPAR Flow-through Monitor the performance of competitors via the insightful analysis of a justifi able comp set. Take pricing risks when it is prudent to do so; and accept and learn from mistakes. Create realistic RevPAR and profi t increase goals and broadly communicate those goals within their organizations. Resist the urge to discount rates as a means of increasing profi tability because it is a counterproductive strategy. Communicate to the entire RM team that neither occupancy, ADR, or RevPAR is the end goal—rather, customer-centric and profi table revenue generation is the end goal. Common sense and the right management assessment tools lead to revenue optimization success for RMs, their RM teams, and their hotels. ❖ ESSENTIAL RM TERMS Statistic Income statement Total RevPAR Room-related occupation costs Minimum ADR sales point formula Gross operating profi t (GOP) Flow-through Market share Metropolitan Statistical Area (MSA) Flag SMERF Marketing mix Ancillary revenue 342 CHAPTER 9 EVALUATION OF REVENUE MANAGEMENT EFFORTS IN LODGING

WHAT IS A PRICE? 343 Statistics Last May This May Occupancy % 75% 85% Rooms sold ADR $129.99 $116.99 Rooms revenue RevPAR Controllable operating costs Gross operating profi t GOPPAR 1. Antonio is the RM at the 180-room Hawthorne Suites. Disappointed in his occupancy rate last year, he decided to reduce his room rates this year by 10 percent to help increase sales and improve his RevPAR. This action resulted in an upswing in occupancy, from 75 percent last year, to 85 percent this year; an increase of 13.3 percent. Last year, Antonio’s controllable operating costs were $61.00 per room. This year, they rose to $62.00 per room, an increase of only 1.6 percent. Help Antonio better understand the overall results of his rate reduction strategy by completing his hotel’s May operating performance worksheet and then answering the questions that follow. ➠APPLY WHAT YOU KNOW A. What was Antonio’s RevPAR “Last May?” __________ B. What was Antonio’s RevPAR “This May?” __________ C. What was Antonio’s GOPPAR “Last May? __________ D. What was Antonio’s GOPPAR change from last May to this May: In dollars? _________ In %? _________ E. Compare Antonio’s GOPPAR performance this year versus last year. How effective do you believe Antonio was in devising and implementing his revenue optimization strategy? 2. Paige Vincent is the RM at the City Center Novotel. For over 12 months, she has been working hard to improve the performance of her hotel. Paige just received the following performance data. Help her understand the revenue optimization trends for her property by completing the chart and then answering the questions that follow. Hawthorne Suites May Performance APPLY WHAT YOU KNOW 343

344 CHAPTER 9 EVALUATION OF REVENUE MANAGEMENT EFFORTS IN LODGING A. What was Paige’s occupancy index this month? __________ B. What was Paige’s ADR index for the last three months? __________ C. What was Paige’s RevPAR index this month? __________ D. What was Paige’s RevPAR for the last 12 months? ____________ E. Compare Paige’s property performance for the past 12 months to that of her competitive set. How effective do you believe Paige has been in devising and implementing her revenue optimization strategy? 3. Jamie Lynn is the RM at a 250-room full-service hotel property. Her comp set includes fi ve full- and limited-service properties: Property Number of Rooms Supply Sheraton 235 Radisson 220 Holiday Inn Crown Plaza 271 Hyatt Place 314 Clarion 210 City Center Novotel Performance: RevPAR This month Last 3 months Last 12 months Occupancy % Novotel Comp Set Index This month 57.2 58.1 Last 3 months 55.1 57.7 Last 12 months 51.3 55.6 ADR This month $266.57 $270.15 Last 3 months $244.91 $269.69 Last 12 months $231.45 $268.95 The demand and revenue performance of Jamie Lynn’s hotel for the time period January through May is listed below. 344 CHAPTER 9 EVALUATION OF REVENUE MANAGEMENT EFFORTS IN LODGING

WHAT IS A PRICE? 345 Source of Business Calculation Group With Lawrence Walks Without Lawrence Walks Sold ADR $ $129.00 Total revenue estimate $ $ Daily per room ancillary revenue $8.00 $8.00 Total ancillary revenue $ $ A. Assume there were no changes in the number of rooms offered by the comp set or by Jayme Lynn, during the period January to May. What was Jayme Lynn’s proportion of the comp set’s supply? __________________ B. In which months did Jamie Lynn’s occupancy rate exceed that of her comp set? _____________________ C. In which months did Jamie Lynn’s ADR exceed that of her comp set? _____________________ D. Based on Jamie Lynn’s January results, what rate-related advice would you give her? E. Based on Jamie Lynn’s May results, what rate-related advice would you give her? 4. Jerielle Pelley is the front offi ce manager at the 125-room limited-service Best Stay Inn. She also serves as her property’s RM. Jerielle has just taken a call from Lawrence, a friend and the RM at a hotel within her comp set. Because of an internal oversight, Lawrence’s hotel is overbooked by 70 group rooms next Saturday. Lawrence would like to purchase that number of rooms from Jerielle at their previously agreed upon walk rate of $75.00. Jerielle’s normal rack rate is $129.00. Currently, she has 55 occupied rooms (arrivals and stayovers) on the books for that day. She estimates that she could sell, at her normal ADR, another 30 rooms by Saturday. Complete the source of business worksheet and then answer the questions that follow. Month Demand Revenue January 16.2 23.7 February 18.5 15.5 March 16.7 17.1 April 20.1 20.5 May 23.7 16.2 APPLY WHAT YOU KNOW 345 (continued)

346 CHAPTER 9 EVALUATION OF REVENUE MANAGEMENT EFFORTS IN LODGING A. What would Jerielle’s ADR be if she accepted all of Lawrence’s walked rooms? ___ ________ B. What would be Jerielle’s RevPOR with the walked rooms? _____________ C. What would be Jerielle’s RevPOR without the walked rooms? _____________ D. What would be the dollar difference in her hotel’s total revenue if Jerielle agreed to take the rooms? __________ E. What would be the % difference in her hotel’s total revenue if Jerielle agreed to take the rooms? __________ F. If you were Jerielle, would you accept the walked rooms from Lawrence’s hotel? Explain your answer. 5. Watson Walbert is on the corporate RM team for the Sunbird Hotel Corporation. Sunbird is the franchisor for Red Robin and Falcon hotels. Part of Watson’s job is evaluating revenue and Net ADR Yields for the distribution channels used by the company franchisees. Sunbird charges its franchised hotels a total of 5 percent of gross room revenue for each room sale made. Additional fees (listed as a percentage of ADR) that are assessed for each distribution channel are presented in the following table. Calculate the information required to complete the chart Watson is working on and then answer the questions that follow: Channel ADR Total Fees: 5% franchisor fee PLUS an additional; Net ADR Net ADR Yield Third-party Web sites $166.54 27% Franchisor Web site $229.99 7% Proprietary Web site $239.99 5% Travel agent $209.59 11% Group With Lawrence Walks Without Lawrence Walks RevPOR $ $ Total revenue Revenue Variance Amount $ % 114.6 346 CHAPTER 9 EVALUATION OF REVENUE MANAGEMENT EFFORTS IN LODGING Source of Business Calculation (continued)

WHAT IS A PRICE? 347 KEY CONCEPT CASE STUDY “Thanks for coming in, Damario,” said Sofi a Davidson, the GM at the Barcena Resort. Damario, the revenue manager at the 480- room Barcena Resort had now been on the job for 12 months. “I’ve been reviewing the data from last month and I have to tell you, the owners are really pleased with our progress,” said Sofi a. “I’m pleased, too,” said Damario. “We’ve come a long way.” “Our occupancy index for the past three months has exceeded our comp set by 10 points, and you’ve managed to keep our rate index in the high 90s,” said Sofi a. “That’s a real credit to our RM team,” Damario replied. “You’re being too modest. The forecast and pricing systems you designed and implemented for us are going great. The controller is happy, the DOSM is happy, and that makes me pretty happy too!” said Sofi a. “What’s next? “We still have some real challenges,” replied Damario, “but I think we are ready for the next big step.” “And what would that be?” asked Sofi a. “I want to get the Strategic Pricing and Revenue Management Advisory Committee to become more aggressive. I want to eliminate our lowest-yield channels and focus even more on our best customers,” said Damario. “Best as in highest rated? That does make sense,” said Sofi a. “But what exactly will that mean for us?” “Rate increases, for one thing,” replied Damario. “I believe we are ready for our fi rst signifi cant rate increase in a long time. I’m thinking an 8 percent RevPAR increase for next year is a realistic target. Based on our guest feedback results, I know we can do it. And I want to get more involved on the F&B pricing side. I think we can make great strides there as well.” For Your Consideration 1. What evidence in the conversation between Sofi a and Damario would lead him to believe the property was ready to seek signifi cant rate increases? 2. Assume you were on Damario’s RM team. Since the property’s room rates are below the competitive set’s, what specific additional data would A. Which source provides the hotels with their highest net ADR? ______________ B. Which source provides the hotels with their lowest net ADR? ______________ C. What is the net ADR yield on rooms delivered via this hotel group’s franchisor operated web site? ______________ D. What is the net ADR yield on rooms delivered to the hotels via travel agents? _____ _______ E. Which source provides the franchisor with the highest per-room revenue? _______ F. Which site provides the franchisees with the highest per-room revenue? ________ APPLY WHAT YOU KNOW 347

348 CHAPTER 9 EVALUATION OF REVENUE MANAGEMENT EFFORTS IN LODGING ENDNOTES 1. Excerpt from Accor, August 2008 Report to shareholders; at http://www.accor.com/gb/upload/ pdf/CP_S1_VA.pdf. 2. Joe Griffi th, Speaker’s Library of Business (Englewood Cliffs, NJ: Prentice Hall 1990), 65. 3. http://thinkexist.com/quotes/ernest_a._fi tzgerald/. Retrieved 11/25/2008. 4. http://thinkexist.com/quotes/bill_gates/4.html/. Retrieved 11/26/2008. 5. Robert Reid and David Bojanic, Hospitality Marketing Management, 4th ed. (Hoboken, NJ: John Wiley and Sons, 2006). 6. http://www.carolverret.net/viral/readtopic. php?id=45. Retrieved 9/25/2009. 7. http://www.quotegarden.com/gossip.html. Retrieved 11/29/2008. 8. http://thinkexist.com/quotation/common_sense_ is_the_knack_of_seeing_things_as/145812.html. Retrieved 11/15/2008. be required to convince you that it would be a good time to raise your rack rates? 3. Assume you were in favor of increasing the RevPAR target next year by 8 percent. Would you be in favor of increasing rack rates, reducing discounts offered, or increasing the number of discounted rooms available for sale? What specifi c additional data would you want to see before making your decision? 4. Assume you were Sofi a. Based on his current results, would you favor Damario’s increased involvement in the hotel’s F&B pricing systems? 348 CHAPTER 9 EVALUATION OF REVENUE MANAGEMENT EFFORTS IN LODGING

CHAPTER 10 Revenue Management for Food and Beverage Services CHAPTER 1 1 Eva l u a t i o n o f R e ve n u e M a n age m e n t E f f o r t s i n F o o d and Beverage Services REVENUE MANAGEMENT FOR FOODSERVICE OPERATORS PART III

Revenue Management for Food and Beverage Services CHAPTER 10 CHAPTER OUTLINE Traditional Foodservice Pricing Methods Product Cost Percentage Product Cost: Plus Contribution Margin The Case Against Cost-Based Foodservice Pricing Applying Differential Pricing in Foodservices Factors Affecting Value Perceptions in Foodservices Competition Service Levels/Delivery Format Guest Type Product Quality Portion Size Ambiance Meal Period Location Image Sales Mix 350

CHAPTER HIGHLIGHTS 1. Detailed review of traditional menu pricing methods. 2. Examination of the shortcomings of utilizing only product cost as the basis for pricing menu items. 3. Overview of selected factors utilized for applying differential pricing to foodservice operations. TRADITIONAL FOODSERVICE PRICING METHODS A designated position termed revenue manager is not as well recognized in the foodservice industry as it is in the lodging industry. In fact, many foodservice operators would equate the duties assigned to a revenue manager in foodservice with those of the person responsible for determining menu prices and, perhaps, for the marketing or advertising of the business. Of course, the proper determination of menu prices is very important. Today’s foodservice RMs should know that the careful examination of how industry professionals can best establish menu prices is not a new phenomenon. The fi rst edition of Lendal Kotschevar’s Management by Menu was released by the National Institute for the Foodservice Industry (NIFI) in 1975.1 The fi rst edition of Jack E. Miller’s classic book Menu Pricing & Strategy was also published over 30 years ago (1980).2 Both of these texts are important because in them these two industry educators/leaders demonstrated considerable insight regarding the challenge of establishing menu prices. In that regard, they could be considered among the innovative RMs of their time. Both books have been continually revised and updated. A review of past (and present) best practices related to menu pricing strategies will inevitably lead you to two interesting conclusions. The fi rst is that restaurateurs and hoteliers seemingly have very little in common when it comes to pricing. The second is that, despite some thoughtful suggestions to the contrary, the menu pricing techniques used by most foodservice operators have remained relatively unchanged during the past half century, while the industry itself has changed radically. Both of these conclusions deserve further examination. The foodservice and lodging industries are both considered part of the larger hospitality industry, but the revenue management and pricing strategies used by most restaurateurs are worlds apart from those utilized by hoteliers. A few examples will illustrate some of the many differences. Recall from Chapter 4 what the hotelier’s likely response would be to the guest who wishes to purchase ten or more guest rooms for a single night. In most cases, such a guest would be referred to the hotel’s group sales department where, because of the large number of rooms to be purchased, discounts off of full (rack rate) prices would be assumed by both parties. A price would be negotiated, an agreement made, and the rooms would be sold. Contrast that to the experience of a guest arriving at a restaurant seeking a table for ten TRADITIONAL FOODSERVICE PRICING METHODS 351

352 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES diners. In most table service restaurants, such a guest would be assessed a mandatory service charge of 10 to 20 percent. This charge would be automatically added to the customer’s bill. The result is that the service charge effectively serves as a price increase (not decrease) for a larger sale. Hotels routinely discount for large sales. Restaurants either increase prices for large sales or leave their prices unchanged. They do not generally discount their prices for large sales. For a second example of pricing differences, consider the situation that exists when, on a day in the future, it is common knowledge that all of the hotel rooms in an area will be sold out. Examples of such days might include those with large sporting events, festivals, or graduations. On days like these, you can be sure hoteliers have either increased their room prices or at the least have eliminated the ability of their guests to buy rooms at a discount. For restaurateurs, on the other hand, such a high demand day means two things will be true: 1. They will be very busy and thus customer waiting times to get in will be long. 2. They will maintain their normal menu pricing structure. A fi nal illustration of the differing revenue management strategies employed by restaurateurs and hoteliers is especially instructive. Consider that, on the slowest business day of the week or month, most hotel RMs aggressively employ their discount-oriented programs and distribution channels in an attempt to capture maximum market share. The wisdom of such actions may be questionable, but there is no doubt the tactic is commonly applied. In contrast, on the slowest day of the week, most restaurateurs charge the exact same prices that they charge on the busiest day of the week. With few exceptions (i.e., two-for-one promotions or discount coupons good only at certain times), most restaurateurs and bars do not equate a change in guest demand for products with a rationale for modifying prices. Interestingly, this is true even for food and beverage operations located within hotels. As these three examples illustrate, foodservice operators apply very different pricing strategies than do lodging industry RMs. If you are to be a professional RM, the reasons why this is so are worthy of examination. If you undertake a detailed review of how most foodservice industry experts suggest menu prices are to be determined, you will discover that their recommendations vary only slightly. In general, the experts suggest that menu prices be assigned on the basis of one of the following general concepts: Product cost percentage Product cost: plus Contribution margin Product Cost Percentage In 1936, George L. Wenzel, director of the Institute for Fine Cooking, published a large loose-leaf pamphlet titled the American Menu Maker in New York. This pamphlet would go on to be the forerunner of the 1,000 page Wenzel’s Menu Maker; the book that would become the standard for the teaching of foodservice operations for the next 35 years. In the Essential RM Term Table service: A restaurant style in which guests are served while seated in a dining area.

fi rst edition of Wenzel’s Menu Maker (1947), the author explains the importance of food cost percentage with the beautiful clarity of the times: “Since the percentage of profi t runs between 5 percent and 20 percent, any increase in food cost, payroll or other expense percent will decrease your net profi t just that much.”3 Wenzel’s advice to budding restaurateurs was quite logical and very direct: Predetermine your desired food cost percentages, maintain them, and thus you maintain your desired profi t levels. Those foodservice operators taught to utilize a product cost percentage pricing philosophy establish their selling prices based primarily on the prices they themselves pay for the ingredients that make up their menu items. This pricing approach can be defended for two important reasons. The fi rst is that successful restaurateurs know the value of serving good food. Good food usually costs more to produce than lower-quality food. As a result, it is only logical, for example, that an operator charge guests more for a 12-ounce USDA Prime New York strip steak than for a 4-ounce hamburger. The steak costs the operator more and thus must sell for more. This operator would further rationalize that knowledgeable diners would also expect to pay more for the steak than the burger. Thus, to some degree, the price expectations of guests are determined, in part, by the product purchased. The operator would even further reason that those menu items that cost the business more to buy must sell for more, and that guests will be willing to pay more for them. The second piece of logic used by those who set menu prices based on product cost relates directly to the four cost categories of most importance to them. These are commonly identifi ed by foodservice accountants as: 1. Products (food and beverages) 2. Labor 3. Other expenses 4. Profi t To illustrate how these four categories are viewed, assume that a single dollar of revenue represents 100 percent of the income that could be devoted to them. It follows that a portion of that dollar must go to pay for the products sold, another portion for the labor required to prepare and serve the item, another portion for all other expenses required to operate the business (i.e., dishes, napkins, rent, marketing, utilities, loan payments, and the like) and, as Wenzel clearly pointed out, a fi nal amount representing the operation’s profi t must remain. If any of the fi rst three categories take too large a percentage of the income dollar, not enough will be left over to pay planned profi ts to the owner of the business. To ensure their pricing takes into account both of these concerns (the cost of the product and the product cost as a percentage of revenue), restaurateurs developed and utilize the following pricing formula that does just that: Cost of products sold All product sales 5 Product cost % Essential RM Term Product cost percentage (pricing method): A pricing method that relies on product cost percentage targets when determining menu prices. TRADITIONAL FOODSERVICE PRICING METHODS 353

354 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES This formula can be worded somewhat differently for a single (food) menu item: Item food cost Selling price 5 Item food cost % The principles of algebra allow operators to rearrange the formula as follows: Item food cost Item food cost % 5 Selling price It is easy to see that this method of pricing is based simply on the idea that an item’s cost should be a predetermined percentage of its selling price. When operators apply the formula, they carefully determine the costs they will incur (the numerator), then use that information to determine target percentages (the denominator) for each cost category. When the targets have been established, the product percentage target dictates the menu pricing decision. Increases in costs in any category (e.g., food, beverages, labor, or other expense costs) can easily be factored into the percentage targets to create new (and lower) ratios that still yield profi t-producing totals. To illustrate the process, assume that an operator created the following cost category targets: Assume also that the operator has developed a menu item that can be produced for $1.50 in ingredient costs. With a targeted product (food) cost percentage for that item of 40 percent, the pricing formula would be applied as: Item food cost Item food cost % 5 Selling price or $1.50 40% 5 $3.75 Thus, in this example, the recommended selling price with a $1.50 item food cost and a 40 percent targeted food cost percentage is $3.75. Experienced foodservice operators know that a second formula for arriving at appropriate selling prices based on predetermined product cost percentage goals can also be employed. This method uses a pricing factor (multiplier) that can be assigned to each desired food cost percentage. Essential RM Term Pricing factor (foodservice): A constant number used to help determine foodservice product menu prices. Cost Category %Target Products 40% Labor 34% Other expense 16% Profi t 10% 100%

Thus, if you were attempting to price a product and achieve a product cost of 40 percent, the pricing factor would be calculated using the following formula: $1.00 Desired item food cost % 5 Pricing factor or $1.00 40% 5 $2.50 Figure 10.1 details a pricing factor table for desired item food cost percentages from 20 percent to 45 percent. A pricing factor, when multiplied by the item’s cost, will result in a selling price that yields the desired item cost percentage. For example, the pricing factor of 2.5 multiplied by an item food cost of $1.50 will yield a selling price that is based on a 40 percent food cost. The computation would be as follows: Pricing factor  Item food cost  Selling price or 2.5  $1.50  $3.75 Astute readers will recognize that these two methods of arriving at proposed selling prices yield identical results. Mathematically, one formula relies on division while the other relies on multiplication. With either approach, operators determine selling price based on Figure 10.1 Pricing Factor Table Desired Product Cost % Factor 20 5.000 23 4.348 25 4.000 28 3.571 30 3.333 33 1/3 3.000 35 2.857 38 2.632 40 2.500 43 2.326 45 2.222 TRADITIONAL FOODSERVICE PRICING METHODS 355

356 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES the goal of achieving a predetermined food or beverage cost percentage for each product sold. When utilizing this pricing strategy, operators typically view those menu items with lower product cost percentages more favorably. This is the oldest and most traditional menu pricing system currently in use and it is still in widespread use today. Product Cost: Plus A product cost: plus menu pricing system simply considers an item’s product cost, plus any number of additional cost-related factors, when determining selling price. One of the most popular cost: plus pricing systems involves the calculation of a menu item’s prime cost. A prime cost is simply the product cost of a menu item plus the cost of the labor required to produce it. The item’s prime cost is then used to establish its selling price. There are a variety of these cost: plus systems, but all have grown out of astute foodservice operators’ recognition of some shortcomings of menu pricing systems based solely on product cost percentages. Figure 10.2 lists some of the cost categories that, either by percentage or dollar amount, are often added to a product’s ingredients cost to aid operators in menu price determination. All of the cost: plus pricing systems that have been developed result from the very logical effort by foodservice operators to include additional expense-related variables to their product pricing models. The concept of actually modifying the product cost percentage approach to include additional costs (a fairly recent and quite radical idea at the time) was fi rst proposed by Penn State University’s hospitality professor James Keiser and industry consultant Elmer Kallio. In 1972, their newly published hospitality textbook included this revolutionary thought: “Although meal pricing is based primarily on the cost of food . . . with the increased use of electronic data processing, it may soon be easier to include labor costs—and other costs—in the calculation of specifi c selling prices.” 4 Today, of course, advanced computer programs exist to help operators easily consider any number of additional costs they desire when they calculate their menu prices, and the many operators who embrace the cost: plus pricing approach frequently do just that. Essential RM Terms Product cost: plus (pricing method): Any of a number of pricing methods that consider product cost as well as one or more additional costs when determining selling price. Prime cost: The sum of the product cost and labor cost required to produce a menu item. Menu Price Product Cost Plus Variable labor cost Product Cost Plus Fixed labor cost Product Cost Plus Total item labor cost Product Cost Plus Selected controllable expenses Product Cost Plus Proportional overhead cost per item Product Cost Plus Desired per item gross profi t Figure 10.2 Alternative Components of Cost: Plus Pricing Systems

Contribution Margin Interestingly, the next signifi cant menu pricing-related development was initiated outside the hospitality industry by the Boston Consulting Group (BCG). BCG is a global management consulting fi rm founded by Harvard Business school alumnus Bruce Henderson in 1963. In the early 1970s, BCG created and popularized its growth-share matrix, a 2  2 chart (matrix) designed to assist large corporations in deciding how to allocate cash among their business units. Using preestablished defi nitions of profi tability, BCG showed businesses how to categorize each of their individual business units as a “Star,” “Cash Cow,” “Question Mark,” or “Dog” based on its ability to generate cash. The business’s leaders would then use this information to allocate future fi nancial resources among the business units accordingly.5 The BCG growth-share model rapidly gained popularity in a variety of industries. In 1982, Michigan State University School of Hospitality professors Michael Kasavana and Donald Smith published Menu Engineering: A Practical Guide to Menu Pricing. In it, Kasavana and Smith argue that contribution margin (CM) was a more important factor in identifying profi table (and properly priced) menu items than was product cost percentage. Essential RM Terms Contribution margin (CM): The profi t (margin) that remains after a product’s cost is subtracted from its selling price. Selling price  Product cost  Contribution margin Their approach, which they labeled menu engineering, touted the value of menu items that sold well and that had high CM levels. After defi ning popularity as the frequency of a menu item’s sale and identifying those menu items with high (above average) or low (below average) popularity and CM levels, Kasavana and Smith modifi ed Henderson’s 2  2 matrix somewhat and proposed four categories of menu items (renaming some with catchy new titles!), as follows: Stars: Menu items with high popularity and high CM Plow horses: Menu items with high popularity and low CM Puzzles: Menu items with low popularity and high CM Dogs: Menu items with low popularity and low CM To apply menu engineering, a foodservice operation’s menu items are analyzed and, based on their calculated attributes, are placed into one of the boxes illustrated in Figure 10.3. Suggestions for how to promote, reprice, or replace individual menu items based on their matrix placement make up a large part of the information that has since been written about menu engineering. Due in large part to the stature of its authors and partly because of its simple logic, menu engineering was embraced very quickly. Today most foodservice professionals will readily recognize the names of the categories used in its application, despite some academic debate about the best techniques to use when placing individual items within the matrix squares. TRADITIONAL FOODSERVICE PRICING METHODS 357

358 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES To a large degree, the system became popular because it was the fi rst of many with a CM focus. A CM-based pricing system addresses the fundamental problem encountered by advocates of the older product cost percentage–based pricing methods. Proponents of product cost–based pricing systems had always struggled to answer questions such as: “Is it better to sell a $10.00 chicken item with a 30 percent food cost or a $20.00 steak item with a 50 percent food cost?” Clearly, due to the $7.00 CM ($10.00 selling price  $3.00 product cost  $7.00 CM) achieved by the chicken sale, the steak sale, with its $10.00 CM ($20.00 selling price  $10.00 product cost  $10.00 CM) is the more desirable sale. Because restaurateurs take dollars (not percentages) to the bank, it was not too diffi cult to make contribution margin converts out of a great number of product cost percentage advocates. A second and less recognized reason the new system was so quickly embraced is that it was so familiar. This was the case because a CM-based pricing system is simply a slight variation of the older, previously accepted product cost–based pricing system. When CM is used as the basis for pricing, the formula for determining selling price is: Product cost Contribution margin desired  Selling price Notice that product cost is still an essential element in the determination of selling price. Establishing menu prices using a CM system is simply a matter of combining product cost with a predetermined dollar amount of contribution margin. The RMs task in such a system is simply to establish the target CM for each menu item. When using this approach, foodservice operators most often establish different target CMs for different groups of items. For example, in a restaurant where items are priced separately, entrées might be priced to achieve a contribution margin of $8.50 each, desserts a contribution margin of $2.25, and drinks, perhaps, a contribution margin of $1.75 each. To illustrate the use of a CM pricing approach, assume $8.50 is an RM’s desired CM for all entrées sold. Utilizing that target in the previous chicken and steak example, the pricing approach would be: Popularity Contribution Margin Low High High PUZZLE High contribution margin Low popularity STAR High contribution margin High popularity Low DOG Low contribution margin Low popularity PLOW HORSE Low contribution margin High popularity Figure 10.3 Menu Engineering Matrix Menu Item Product Cost Desired CM Selling Price Chicken $3.00 $8.50 $11.50 Steak $10.00 $8.50 $18.50

Those managers who rely on the contribution margin approach to pricing do so in the belief that the average contribution margin per item is a more important consideration in pricing decisions than is food cost percentage. They also believe that applying basic menu engineering techniques will signifi cantly increase an operation’s profi tability. Today, the calculation of product (food or beverage) cost percentage and product cost: plus pricing are standard content in all cost related hospitality textbooks. Despite some spirited debate about their pluses and minuses, the techniques used for applying menu engineering principles are also a standard topic in virtually every recently published pricing and cost related foodservice management text.6 Most recently, some researchers/ writers have sought to modify and expand the CM-based pricing approach by examining the merits of combining food cost percentage analysis with CM,7 or even through adding labor costs to the basic menu engineering model.8 The common feature in all three menu pricing approaches, however, remains their primary focus on what foodservice operators pay for the ingredients used to make their menu items. Foodservice RMs will have no diffi culty identifying a large number of publications detailing a variety of cost-based menu pricing techniques and strategies. To fi nd a list of current publications, go to either the Amazon.com (www.amazon.com) or Barnes and Noble (www.bn.com) web sites. When you arrive, choose the Books category, then enter either Menu Pricing or Food and Beverage Cost Control to review the most recently published works related to the determination of food and beverage prices.  RM ON THE WEB 10.1 THE CASE AGAINST COST-BASED FOODSERVICE PRICING The debate over the best pricing method for use in foodservice is likely to continue for some time. Recall from Chapter 2, however, that utilizing cost as the major determinate in pricing a business’s products is generally not a desirable approach. As a result, as a professional RM it should concern you that applying any of the three cost-based menu pricing strategies you have reviewed thus far is not likely to be an effective revenue optimization strategy. In fact, applying a cost-based foodservice pricing strategy is, in most cases, (pardon the pun) a recipe for disaster. How bad is cost-based pricing? Internationally known management consultant Peter Drucker identifi ed cost-driven pricing as one of the fi ve deadly business sins. In an interview, Drucker pointed out fi ve actions that must be avoided if a business is to be successful. He called these actions “deadly sins” and identifi ed cost-based pricing as the third deadly sin. Commenting on the fallacy of believing that the role of a selling price is to recover an operator’s costs and to ensure making a profi t, he correctly states, “Customers do not see it as their job to ensure manufacturers (or any other business) a profi t.”9 THE CASE AGAINST COST-BASED FOODSERVICE PRICING 359

360 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES In a noncommodity industry, cost-based pricing, in any of its forms, has signifi cant drawbacks. The fact is that if foodservice pricing were actually simple, even the least talented of foodservice professionals would be able to successfully calculate their costs, add a desired profi t level (or CM), and determine menu prices that their guests would consider appropriate. Foodservice pricing is not simple. The failure rate for restaurants is among the highest of any business. This is due, in many cases, to inappropriate product pricing. To better understand the diffi culties inherent in implementing effective foodservice pricing strategies, RMs might consider an interesting fact. A review of today’s most popular hospitality marketing texts fi nds that these publications always include a detailed discussion of hotel guest room pricing, but they do not address the specifi cs of food and beverage pricing. In fact, detailed food and beverage pricing strategies have historically been presented and debated in hospitality accounting or cost control courses; not marketing courses (Note: please reread this sentence now to ensure you understand its signifi cance!). This placement variance refl ects the reality that, in most cases, hotel room pricing decisions are driven by a hotel organization’s sales and marketing staff while foodservice pricing has primarily been the domain of F&B operations or accounting and fi nance specialists. These F&B specialists have been taught to rely on cost-related data to establish their prices. RM IN ACTION 10.1: AND THE SPECIAL TONIGHT IS . . . Ask a foodservice professional to explain the term “special” and they will likely tell you about the chef’s latest creation—an item that requires special skill or is exceptionally unique. Lynne Nowick, a Republican politician in Suffolk (New York), sees it differently. According to a Newsday report published in Restaurants and Institutions, Ms. Nowick stated, “People hear the word special and they think it’s going to be a bargain. Many times it’s not. And sometimes people—young people on a fi rst date or the elderly are too embarrassed to ask.” Based on her defi nition of “special,” Nowick has proposed local legislation that requires prices on all food items, including specials, be listed on a printed page with the menu or posted in a way “readily observable.” Jerry Marlow, vice president of the Long Island chapter of the New York State Restaurant Association and owner of Collins and Main in Sayville, said the association has taken no stand on the bill. He instructs his own waiters, who verbally describe specials to customers, to detail their prices as well. Marlow’s position refl ects what should be the view of all customer-centric revenue managers: “We’re not trying to hoodwink anybody; Nowick’s proposal is fair to consumers.” Nowick’s proposal does serve as a reminder that pricing must always be considered by guests to be fair, even when the guest may be confused about what an RM likely means when a term such as “special” is used. Often, fairness in pricing is perceived as less about the amount charged than the way in which a price is communicated. Guests should not be placed in the uncomfortable position of having to ask the price of an item not included on a menu. Transparency and clarity in pricing should be a trademark of the revenue optimization decisions made by all customercentric RMs. Excerpted on 12/01/2008 from www.rimag.com.

Thus, a legitimate question for professionals in the emerging fi eld of foodservice revenue optimization is rather stark in its simplicity: “Is foodservice pricing essentially an accounting issue or a marketing function?” The authors would answer the question as neither. We would propose that foodservice pricing and revenue optimization strategy is simply too important to be considered as only one, among many, of the important topics to be addressed by either operations, fi nance, or marketing professionals. Indeed, as much as any other business challenge, this very issue is one of the best possible arguments for designating highly trained RMs as the pricing experts within foodservice organizations. The lodging industry increasingly understands the importance of inventory management and strategic pricing and has embraced specially trained RMs. The foodservice industry should do likewise. To better understand the complexity of food and beverage pricing and exactly why trained pricing professionals are so needed, it is important to recognize that in foodservice, an important distinction must be made between total sales revenue and sales volume—or the number of units sold. To illustrate, consider a bagel shop manager whose Monday business consists of $4,000 in total sales (revenue) because she sold 2,000 bagels (sales volume) at $2.00 (selling price) per bagel. Foodservice revenue and price are not synonymous terms. Revenue refers to the amount spent by all guests, while price refers to the amount charged to one guest. In the foodservice industry, total revenue is generated by the following formula: Selling price  Number (volume) sold  Total revenue From this formula, the two important components of total foodservice revenue are easily identifi able. Selling price is one component; the other is the number of items sold. In foodservice, variation in selling price (menu prices) will directly affect the number of items sold. As is true in the lodging industry, selling price and number sold are interrelated in the foodservice industry. Recall from Chapter 2 that in many cases, as price increases, the number of items sold at that price will decrease. Given suffi cient demand, the opposite is also true—as price decreases, the number of items sold at that price will increase. For this reason, price increases (or decreases) must be evaluated based on their impact on total revenue generation and not on the number that represents the fi nal selling price. To illustrate, assume you are the RM for a chain of specialty coffee shops. Due to rising ingredient costs, you are considering raising the price of the breakfast pastries sold in your shops from $1.99 to $2.29. Figure 10.4 illustrates the possible effects of this price increase on your total revenue in a single unit that has been selling 200 pastries per day. Note especially that, in at least one scenario, increasing price has the effect of decreasing total revenue. Experienced foodservice managers know that increasing prices due to their increased costs, without giving added customer value, will no doubt result in higher menu prices. Most frequently, however, it also results in lowered total revenue due to reduced guest Essential RM Term Sales volume (foodservice): The number of a single menu item sold during a defi ned accounting period. THE CASE AGAINST COST-BASED FOODSERVICE PRICING 361

362 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES counts or guests’ per-visit purchases. This is true simply because foodservice guests (like lodging industry room buyers), are not concerned about an operator’s costs. Increased costs do not automatically equal to an increase in customer’s perceived value. Buyers are, however, very concerned about those things that do impact their perceptions of a business’s price/value offer. So how important are costs? As co-authors of an internationally best selling book devoted solely to food and beverage cost control, the answer is that costs and their control are very important to profi tability. However, “No amount of effective expense (cost) control can solve the profi t problems caused by inadequate revenue resulting from inferior food quality or service levels.” 10 For some foodservice operators, ineffi ciency in cost control is passed on to guests in the form of higher prices. An increase in costs cannot be automatically allowed to decree an increase in selling price. In fact, the opposite should be true. An appropriate selling price for a product or service must dictate the item’s cost. Savvy RMs working in foodservice learn that price comes fi rst; then allowable costs can be calculated. Selling prices must accurately refl ect consumer perceptions of value. When these types of prices are established fi rst, a business can then compute the costs it can reasonably incur while still generating required profi ts. If you recognize that two diamonds of the same size and quality will have equal value even if one was discovered accidentally on the ground and the other took the expense of a year’s labor and equipment to uncover, then you can see why costs should not be allowed to dictate prices. For the foodservice industry, even more so than in the lodging industry, sound pricing must be based not on cost but on establishing a positive price/value relationship in the mind of the guest. This is essential, in large part due to the greater number of alternatives available to foodservice customers. As illustrated in Figure 10.5, a foodservice organization chooses from two basic options when pricing its products. The fi rst relies on cost and results in menu prices desired by the operator. The operator’s hope in such a case is that guests will agree that the price is fair and represents good value. While hope is an appropriate strategy when playing slot machines or buying lottery tickets, as a business strategy, it is not one of the best. This is especially apparent Figure 10.4 Possible Results of Pastry Price Increases Original Price Number Sold Total Revenue Revenue Result $1.99 200 $398.00 New Price Potential Impact of New Price $2.29 Increased customer count 250 $572.50 Increase $2.29 No change in customer count 200 $458.00 Increase $2.29 Decrease in customer count 173.8 $398.00 No Change $2.29 Decrease in customer count 150 $343.50 Decrease

when the hope is based on the questionable position that guests view the costs you incur as synonymous with the value you deliver. They do not. Option B in Figure 10.5 recognizes that guests ultimately determine menu prices based on the value delivered to them. Note also, however, that this option includes recognition of allowable costs; which is the amount an organization can spend to produce a product given their own guests’ perception of the product’s value. RM IN ACTION 10.2: RECONSIDERING THE VALUE PROPOSITION Nation’s Restaurant News (NRN) reported that after recording a 19-percent drop in secondquarter profi ts and warning of further declines in same-store sales for its two main brands, The Cheesecake Factory Inc. said today that it would try to reverse the downturn, in part by reconsidering the value perception of its namesake chain. Interestingly, quarterly revenues for the same period were up 9 percent due to new restaurant openings. For RMs, an important lesson that can be learned is that additional stores (or even increased individual guest sales) do not automatically lead to greater profi ts. In the report, David Overton, Cheesecake Factory chairman and chief executive, was quoted as saying: The chain . . . will look at “tweaking” the Cheesecake Factory’s value proposition by region. I think we’re still seen as offering value, but you have to be careful in this environment. Note Overton’s use of the term; value proposition. As an RM, you must champion the concept within your organization that it is value delivered, not your production costs, that matter most to guests. In fact, it is the value you deliver to guests that ultimately determines your allowable prices. Those are the prices that must dictate your allowable costs if you are to be a profi table and viable foodservice organization. Excerpted on 8/10/2008 from www.nrn.com. Determines Option A Production Cost Option B Value Proposition Desired Menu Price Allowable Menu Price and Costs Dictates Figure 10.5 Food and Beverage Pricing Approaches THE CASE AGAINST COST-BASED FOODSERVICE PRICING 363

364 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES RM AT WORK 10.1 “$28.95—that’s almost ten dollars more than we charged for it yesterday!” said Shana, the Dining Room manager at Chez Paul’s restaurant. “It’s even more than our highest priced steak!” Shanna was discussing the day’s dinner menu with Henri, the restaurant’s chef. Henri had just delivered to Shanna the daily menu insert that her service staff would use that night. On the night’s new menu she noticed that the price of Huachinango a la Veracruzana (Red Snapper with Spicy Red Sauce), one of the operation’s signature dishes, had increased overnight. Yesterday it sold for $19.95. Today Henri had priced it at $28.95. “Tell me about it,” replied Henri, “our seafood supplier really jacked our price on the new shipment. Claimed there was a supply shortage. Price went up almost $7.00 per pound. Over $3.00 a portion. Might last for two or three weeks. You know how Mark is. If I don’t keep a 36 percent food cost . . . or less, it could mean my job. With the new cost of snapper, I needed this increase to keep the food cost ratio in line.” Shanna knew it was true that Mark, the restaurant’s manager, did keep the pressure on to control costs in both the front and back of the house. In this case, however, Shanna wasn’t sure that her servers or the customers they would serve that night would be very happy with Henri’s pricing decision. The snapper was a very popular item, and that meant tonight lots of customers would notice the price increase. 1. Assume you were a server at Chez Paul’s on the night this new menu price was initiated. How would you respond to a returning guest who questioned the signifi cant price increase on the snapper item? 2. Assume you were a regular customer at Chez Paul’s, and that the snapper was your favorite item. How would you likely respond to the new menu price? If you bought it, would you consider the item to have delivered an extra $9.00 of value to your dining experience? 3. Do you think Henri’s new menu price was a direct result of Mark’s cost-based pricing philosophy? How would you have advised Henri to respond to the increase in red snapper cost? In Chapter 4 you learned that differential pricing—the strategy of charging different prices to different buyers for the same, or for slightly different versions of the same product—is a powerful revenue optimization tool. It is a tool that, unfortunately, has been used too sparingly by some foodservice operators. Historically, most restaurateurs have established a single price for the various menu items they sell and then have left the prices alone until the next time the menu was printed. At the time of a menu reprint, individual menu items would be added or removed based on their popularity or cost. New menu items would be considered and, if added to the menu, their costs would be calculated. Based on these new costs, and using the restaurant’s preferred menu pricing method, the new menu item’s price would be established. Finally, revised menus or menu boards APPLYING DIFFERENTIAL PRICING IN FOODSERVICES

with the updated prices would be created. The point-of-sale (POS) system would be reprogrammed to refl ect the new prices and the updating process would be complete. Today, signifi cant advances in print, display technology and POS system programming could allow this historical procedure to change radically. Differential pricing based on guests’ view of value and willingness to pay, however, has been implemented only warily as a revenue optimization strategy RM IN ACTION 10.3: VALUE? . . . TO WHOM? In 1989 Wendy’s introduced its 99¢ Value menu. McDonald’s created its Dollar Menu in 2002. Burger King rolled out its similarly priced BK Value Menu in 2006. These chains, as well as others, still offer a variety of value menu items at the same 99¢ to $1.00 price point. Some customers love value menus, as do franchise companies whose fees are based on a franchisee’s gross sales; not the franchisee’s profi ts. RMs in foodservice, however, must take a serious look at the longterm impact of selling food only on the basis of its “low cost.” The times (unlike value menu prices) really do change. Unlike their selling prices, restaurants’ costs of doing business have not remained fi xed over the years. Minimum wage levels and food prices have increased, as have insurance, energy, and many other costs. In 2008, the owners of four Manhattan Burger King franchised units fi led suit against Burger King. These operators claimed they simply could not make money when offering value menu items in their Burger King franchised Manhattan stores (due to the high costs associated with operating in New York City). Referring to the lawsuit, Rich Gallucci, one of the franchisee’s attorneys, was quoted in Franchise Times as saying: It’s not a suggestion that the value menu doesn’t benefi t someone. Obviously, if you go in and purchase a hamburger for 99 cents, it benefi ts you as a consumer and it benefi ts the corporation. But it does nothing to help the franchisee. Some industry experts have mixed feelings about the true value of value meals because they are seen as a mixed blessing. Advocates state that value menus undoubtedly drive traffi c to stores. They maintain that customers like these value menus and, the reasoning continues, customers must be given what they want. Interestingly, General Motors (GM) made the same supposedly customer-oriented argument when asked by Congress why it sold so many large SUVs and trucks from 2000–2008. Prior to its bankruptcy fi ling, GM’s CEO was vilifi ed, chastised, and removed from his position for building the wrong car types despite his protests of “that’s what the customer wanted.” The job of business leaders is to ensure the long-term viability of their businesses. Thus, it is not necessarily wrong for professional RMs in the foodservice industry to follow the lead of Burger King franchisees who, in 2009 twice voted against a franchisor recommended expansion of their value menu.11 They, like all professional RMs, are right to legitimately question the long-term wisdom of any business strategy that seeks to increase top line revenues chiefl y by selling items at prices so low they prevent the operation from making a reasonable profi t on their sale. Excerpted on 12/08/2008 from www.franchisetimes.com. Essential RM Term Point of sale (POS) system: A computer system used to record and retain sales data. APPLYING DIFFERENTIAL PRICING IN FOODSERVICES 365

366 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES in foodservice. This is likely the case because a “Set them and forget them” mentality (the inevitable result of cost-based menu pricing) most often results in a “we only change prices when our costs change” mentality. Unfortunately, too often an overemphasis on product cost results in the use of outdated and ineffective revenue optimization strategies. One example of this is the overdependence on low prices as a means of increasing revenue. RMs in foodservice, like their lodging industry counterparts, must be very careful to avoid commoditization of their products and services. Recall from Chapter 8 that commoditization is the process by which a branded product or service reaches a point in its development where the brand has no features that differentiate it from other brands. As a result, consumers buy on price alone. Successful restaurateurs know that seeking to compete solely on the basis of low cost is a losing strategy. They also know that most foodservice operators face fairly similar costs when selecting the items they will sell. Whether the product sold is oranges or beer, wholesale prices typically vary only slightly from one supplier to the next. The result, in too many cases, is that competing foodservice operations, all of which are paying nearly identical prices for their own goods, inevitably reduce quality to reduce their costs (and thus maintain or reduce their selling prices). Unfortunately, this cost-based action frequently leads to reduced perceptions of the value they offer their customers. Such an approach is bad for an individual foodservice unit and bad for the entire foodservice industry. This is so because value is not just about attracting guests with low prices. It is about meeting guest expectations. In the foodservice industry, a good value is the right quality product in the right portion size accompanied by the right service for the right price. This concept was articulated well by Brad Nelson, corporate chef for Marriott International, when he stated: “It still has to be value with quality; it is not just about making it cheaper. You have to stick with quality levels because, frankly, people are not going to waste [time and money] on poor-quality products.”12 You know that if you wanted to buy a car you would not likely purchase the car that sells for the very lowest price in your area. That car probably would not even start! Rather, you would look for the car that provided you the most value for the price you could afford. In a similar manner, if you were purchasing a clothing item, such as blue jeans, for yourself it is unlikely you would choose the absolutely lowest priced jeans you could fi nd. Because you recognize there are quality differences in jeans, you are most likely to behave rationally and choose the jeans that provide the most value to you. In many ways, the value offered by service providers is even more important than the value offered by product providers. If you are purchasing a car, you can inspect it and drive it prior to its purchase. You could try on jeans before purchasing them. As you learned in Chapter 3, however, the intangibility of services makes choosing service providers more diffi cult and less based on price. If, for example, you were choosing to hire a fi nancial investment fi rm to help you manage your wealth, you would likely be very cautious about choosing a company that sought to win your account by proudly advertising it was the lowest priced supplier of investment advice in your area. In a similar manner, if one of your loved ones needed heart surgery, it is doubtful that a surgeon would win your confi dence if they sought to win patients by offering to provide the lowest priced heart transplants in your area. In any service industry, including foodservice, if the word value comes to be used interchangeably with the words low price rather than higher quality, signifi cant problems

will inevitably result. This is especially true in the sale of food and beverages. Hospitality professionals, more so than the average person, know it is absurd to believe that the quality of all foods and beverage ingredients are the same. The quality of most products (cheese and wine are two excellent examples) vary a great deal. Seeking to sell such products at the lowest possible menu price, rather than at the highest possible value level, makes little sense. Yet it occurs all too frequently. Michael Pollan, popular author of The Omnivore’s Dilemma, sagely observes: “When you think about it, it is odd that something as important to our health and general well-being as food is so often sold strictly on the basis of price.” 13 In Chapter 5 you learned: Strategic pricing is the application of data and insight to effectively match prices charged with individual buyer’s perceptions of value and willingness to pay. Certainly the specifi c food and beverage products sold in an operation have some impact on value perception and some guests’ willingness to pay. As a result, a 20-year old Scotch may well demand a higher selling price than a 5-year-old Scotch. In the same manner, USDA Prime beef steaks will command a higher price than USDA Choice or USDA Select beef steaks. It is important to recognize, however, that the increased quality of these products is not synonymous with increased value and customer willingness to pay. The 20-year-old Scotch or Prime steak will continue to be superior quality products regardless of the price at which you choose to sell them. If your pricing is perceived as excessive, however, the products will not provide good value, nor will your potential customers be willing to pay for them. This is a key point in better appreciating the restaurateur’s common lament that “my customers don’t want to pay for quality.” Customers do not pay for quality. They pay only for value. For many, and perhaps most, foodservice customers, knowledge of quality differences in food and beverage products is too limited to be the main factor affecting their view of foodservice value. Foodservice operators who are often justly proud of the products they choose to sell often fi nd that hard to accept. To prove it to yourself, however, simply ask a non hospitality friend or colleague to tell you the difference between Choice and Select beef. Or between Roquefort and Blue cheese. Or between Prosciutto and a sugar-cured smoked ham. In asking questions such as these, you will quickly fi nd that the average American diner choosing to eat out is buying many things. These include such things as convenience, speed, unique products, social setting, escape, and even romance. But most do not choose their restaurant based on their vast knowledge of variance in the quality of the raw menu ingredients offered to them. In fact, fully discerning the quality and cost differences in purchased food and beverage products may be as alien a concept to the average American diner as the intricacies of those diners’ own various businesses would be to the foodservice operator. While this fact may be somewhat upsetting to restaurateurs who are passionate about the quality of food and beverages they serve, it is a reality that must be addressed by the foodservice operator. As a result, a skilled revenue manager can often more easily point out how creative pricing could be implemented in a foodservice operation than the operation’s own food and beverage production specialists. Foodservice customers do assess the value delivered to them. Most simply do not use product quality/cost to do so. Accepting the premise that many factors other than food and beverage APPLYING DIFFERENTIAL PRICING IN FOODSERVICES 367

368 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES quality are the major determinates of value perception for foodservice customers may require a signifi cant change in thought process on the part of some restaurateurs. Change can be diffi cult; some would even say that it is only babies who truly look forward to change! As an RM working in foodservice, however, you must recognize the critical factors that directly affect the value proposition you make to your own guests, as well as how they will respond to them. If that represents change on your part, it is a change you must make. Foodservice industry revenue managers should recognize the role that differential pricing could play in the industry. In the interest of providing revenue managers with additional menu pricing perspectives, we now consider the applicability of differential pricing in the foodservice industry. You have learned that RMs in the lodging industry know the number of rooms they have to sell is fi xed. Thus, room rates are adjusted based on demand. The same is true in the airline industry. In both industries, selling prices are higher during peak times and lower during off-peak periods. In both cases, customers have become accustomed to this variability. However, in foodservices, most operators have very rarely equated a fl uctuation in demand of services with their ability to charge more or charge less. Perhaps this is because foodservice operators see themselves as selling food and beverage products rather than services. As you have learned, consumers most often look unfavorably upon sellers who raise product prices simply because demand increases (recall the snow shovel example from Chapter 5). In fact, foodservice operators do not sell products as much as they sell capacity. The 100-seat restaurant sells the right to occupy one of the 100 seats for a period of time. Put another way, restaurateurs don’t sell steaks; they rent seats to customers who buy steaks. The purchases made and the amount spent during the period the guest rents the seat dictate the revenues generated. This situation is actually quite similar to the hotelier selling a sleeping room. Both sell a unit of inventory (room or seat) for a period of time. Just as an unsold sleeping room represents revenue loss, so, too, does an unsold restaurant seat. Actually, it is interesting that the foodservice industry has not fully embraced the willingness to pay pricing concept introduced earlier in this book and the differential pricing strategies that logically fl ow from that pricing approach. The hospitality industry has certainly borrowed other ideas from the airline industry. One example is the creation of frequent diner programs patterned after the airlines frequent fl yer programs. In fact it is hard to fi nd a successful restaurant today that doesn’t offer some type of rewards program for its best customers. The concept of utilizing yield in pricing, however, has not been fully embraced by foodservice operators, despite, as shown in Figure 10.6, the several similarities between the ways in which restaurants, hotels, and airlines create gross revenues. Just as hotels have rooms to fi ll, airlines have seats to fi ll and restaurants have a fi xed number of chairs to fi ll. If the chairs are not fi lled with diners the costs associated with lighting, heating, mortgage, and staffi ng the operation are still incurred. Just as the lodging and airline industries take advantage of differential pricing, so too should restaurateurs consider expanding their use of this powerful revenue optimization strategy. Those foodservice operators seeking to sell their products based on the prices they themselves pay for raw ingredients will have no diffi culty fi nding a variety of excellent sources to help them with that process.14 The authors propose, however, that RMs in foodservices take a more aggressive approach in the application of differential pricing. As the economic downturn that began in late 2008 demonstrated so clearly, those restaurants that seek to

maximize revenues via the offering of low prices can easily lose customers to even lower-cost product providers, including grocery stores offering home meal replacement products at prices even lower than those that can be offered by restaurateurs. Can differential pricing successfully be applied to foodservices? In many cases, the answer is a resounding yes! Consider how differential pricing might be applied to full-service restaurants. To do so, envision a scenario in which the restaurant is operated by a talented lodging industry RM. In such a case, that RM would likely fi rst identify the operation’s forecasted peak hours of demand. Assume that, like many restaurants, these high-demand times consisted of a three-hour period every Friday and Saturday night. The lodging industry RM would ask several questions that would logically follow. Each question is worthy of thoughtful consideration: Question 1. Can menu prices be higher on Friday and Saturday night? Assuming no restrictions on the ability to reprint menus or to reprogram the operation’s POS system, this is a legitimate question. Many traditional foodservice operators would be fi rmly against such an approach to pricing. They would state that their guests would have signifi cant negative reactions. An RM advising the foodservice operator might point out, however, that these diners would be the same customers who routinely pay more to fl y during busy periods, rent hotel rooms at a premium price during peak vacation periods, and readily pay more to golf on the weekend than through the week. It is important to realize that there is no contract with foodservice guests that states prices have to be the same every night of the week. How could food and beverage prices refl ect demand? Recognizing that guests prefer pricing discounts to surcharges, operators could take a lesson from their lodging industry counterpart and establish a “rack” menu price. This would be the menu price charged for items when no discounts are offered. It may represent, for example, a premium of 15 to 20 percent (or more) over current menu prices. These rack menu prices could be the prices charged during the three-hour peak Friday and Saturday night dining periods. Discounts off these rack menu prices could then be offered for diners arriving signifi cantly earlier or later than the peak three-hour period Industry Constrained Supply? Capacity Utilization Measure Pricing Measure Gross Revenue Measure Foodservices Yes: seats Customer countª Menu prices/ Check average Total INCOME (Customer count) Check Average) Lodging Yes: rooms Occupancy % ADR RevPAR (Occ.  ADR) Airlines Yes: seats Load % Yield Total Yield (Load  Yield) a Note this measure is not expressed as a proportion (%) of available capacity, a signifi cant weakness that will be addressed in the RevPASH section of the following chapter. Figure 10.6 Gross Revenue Generation: Foodservices/Lodging/Airlines APPLYING DIFFERENTIAL PRICING IN FOODSERVICES 369

370 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES on Fridays and Saturdays, as well as those dining on slower days or during slower periods. The potential advantages of varying the discounts off rack menu prices are evident. Given the traditional pricing practices of the hospitality industry, the implementation of such a rack menu price approach might or might not lead to a negative response from diners. Astute readers who recall Chapter 4 will recognize that this is simply an example of using time as a determining factor when implementing a differential pricing strategy. Half-price happy hours and early-bird dining specials are more traditional foodservice examples of this same time-based strategy. This fi rst reasonable revenue optimization question is presented here in its purest differential pricing form simply as an example of the type of out-of-the-box thinking that will be required if foodservice operators hope to move aggressively away from cost-based pricing systems and toward value-based pricing systems utilizing differential pricing. Additional and, to traditional foodservice operators, perhaps less threatening questions that might be asked by a lodging industry RM in this illustration include: Question 2. Can special menu items be priced higher on Friday and Saturday night? Assume overall menu prices are not increased as suggested in the fi rst question. Are Friday and Saturday nights good days to offer higher-priced specials? The answer may be yes if guests see the specials as providing real value. Just as hoteliers should seek to optimize revenue via the enhancement of value (and price) during high-demand days, so, too, should foodservice RMs. The value enhancements offered must, of course, refl ect the style of restaurant, bar, or lounge operated. As a foodservice RM, it will be your job to identify, by applying data and insight, the best ways for your own operation to enhance diner value during high-demand periods. When you do, you may be able to adjust prices upward on special dishes to refl ect that increased value. High-demand periods such as those identifi ed in this scenario may be an excellent time to do so. Question 3. Can selected menu items be priced lower on Friday and Saturday night? Restaurateurs sell seating space as much as they sell menu items. As a result, the sale of those items that can be prepared and served quickly are simply more advantageous to the operation during a busy meal period than that same item’s sale during a less busy period. It would be logical to consider the impact on total revenues of reducing prices on quick preparation or quick-to-serve menu items to increase the total number of guests served on a day when such a strategy can be applied. Recall that the total revenue formula for a foodservice operation is: Selling price  Number Sold  Total Revenue As you have learned, revenue optimization strategies utilizing differential pricing can often mean lowering prices to attract more customers; resulting in increased total revenues. Question 4. Can preferred seating be offered at a higher price? Both lodging and airline RMs know the advantages they gain by providing low-cost rooms and seats to those buyers who are price conscious while simultaneously offering

upgraded rooms (with preferred amenities or larger size) and seats (for those in First Class or aisles) to the buyers who prefer to pay more to enhance their lodging or travel experience. If, however, you ask the typical foodservice operator whether their customers would pay more to avoid waiting in a long line for a table on Friday or Saturday night, or to pay for the ability to choose the exact dining room seat they prefer in their favorite restaurant, your question might be met with an incredulous look. Ask guests the same questions, however, and you will undoubtedly get an enthusiastic “Yes!” from those select guests who highly value their time and/or the location of their seat. This example again illustrates the power of differential pricing and its potential in foodservice. Note that there is no intent to charge all guests a higher price for the ability to bypass a waiting line or to choose their seat. The option could be offered only to those willing to pay more and, as a result, receive more personal value from their dining experience. In many cases, the problem in implementing differential pricing relates more to convincing the operation’s staff that the enhanced value is worthy of a higher price than it does to convincing guests of the same thing. Question 5. How could our yield be improved? RMs in lodging understand the revenue generating power of operating at 100 percent occupancy. Although it is a fi nancial management concept that has only recently been explored, a restaurateur’s ability to fi ll increasing proportions of his or her available seating will also have a signifi cant impact on the operation’s revenue generating capacity. More guests served in the same time period result in more income and, as a result, yield more profi t. Assuming equal menu item preparation times among different operations, one of the easiest ways a restaurant can improve its revenue optimization (revenue yield) practices is to have a fl exible seating system. That means being able to immediately create a deuce, a three-top, four-top, or larger table so lost seats are minimized (e.g., the result that occurs when seating two or three guests at four-top tables). Optimizing table mix (the number and capacities of various tables) directly impacts an operation’s ability to maximize table turns. Essential RM Terms Deuce: Restaurant industry jargon for a table that seats two guests. Turn (table): The number of times a table (or seat) is used during the same dining period. The formula to calculate table turn is: Number of guests served Number of available seats 5 Table turns For example: “We turned our tables 2.5 times last Saturday night” Is it the role of an RM in foodservices to become so operationally involved that an issue such as table turns is important to them? Absolutely. In fact, while pricing menu items is an essential task for foodservice RMs, their greater role is the assessment of value offered to APPLYING DIFFERENTIAL PRICING IN FOODSERVICES 371

372 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES guests. This includes the ability to maximize seating capacity during busy periods simply because most guests intensely dislike excessive waits. It also includes the identifi cation of operations-specifi c differential pricing factors that can be applied to benefi t guests and to optimize revenues. Certainly the alternative pricing strategies that might be suggested by questions such as those posed by our hypothetical lodging industry RM are not exhaustive. Rather, they are offered as a means of encouraging foodservice RMs to question traditional cost-based pricing approaches and to ask themselves this most important question: How can I effectively use differential pricing in my own food and beverage operation? Foodservice RMs must understand their operations and their customers. They must also understand how those customers will react to the application of various revenue optimization techniques. Remember that a cost-based pricing system is simply not as effective as a more sophisticated differential pricing system. In Chapter 4 you learned that each of the following factors have been used by other industries when developing and implementing differential pricing strategies. Customer characteristic Location Time Quantity In the foodservice industry, revenue yields are a function of the proportion of seats that are fi lled by diners and the length of time each guest remains at the table. To better monitor and manage the guest seating process, savvy RMs increasingly recommend the use of a high-quality table management system. Such systems interface with an operation’s POS, provide the host or hostess a graphical fl oor plan that provides the visual information needed to manage fl oor activity and to accommodate special seating requests. The systems also calculate guest wait times and help maximize table turns. Such systems automatically update an operation’s available table status and can interface with pager systems to notify guests instantly when their table is ready. Real-time and historical reporting on guests served, serving times, server performance, and guest preferences are additional available features. To learn more about one such popular table management system, go to www.reserveinteractive.com When you arrive at the home page, click Table Management.  RM ON THE WEB 10.2

Distribution channel Product Version Bundling Payment terms In addition to these important factors, RMs should recognize that there are additional foodservice-specifi c factors that affect food and beverage customers’ perceptions of value and thus directly impact these customers’ willingness to pay. Understanding the factors that affect guest perceptions of value is essential to creating differential pricing programs that will allow you to match your food and beverage prices with your customers’ perceptions of value and their willingness to pay. One important job of RMs in foodservice is to carefully evaluate the revenue enhancement opportunities available to them. The proper application of strategies to optimize revenues will vary based on the individual operation, but should always be based on what you now know about price, value, and the desirability of differential pricing. While each foodservice operation is unique, for many RMs, key factors to be considered for their ability to infl uence revenue management strategy include: Competition Service levels/ delivery format Guest type Product quality Portion size Ambiance Meal period Location Image Sales mix Competition This factor is sometimes too closely monitored by foodservice operators. When competitors’ prices are overemphasized, the common result is that the observer’s own prices drop until they are the lowest or among the lowest price for similarly offered products. In fact, competitors’ price monitoring makes sense only when it is performed with the goal of staying on the upper, not lower, end of the pricing scale. This is so because small variations in price simply make little difference to the average guest. FACTORS AFFECTING VALUE PERCEPTIONS IN FOODSERVICES FACTORS AFFECTING VALUE PERCEPTIONS IN FOODSERVICES 373

374 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES For example, if a group of young professionals goes out for pizza and beer after work, the major determinant in their location choice certainly will not be whether the selling price for the beer is $5.00 in one establishment and $5.50 in another. Successful foodservice operators spend their time focusing on building guest value in their own operation, not in attempting to mimic the pricing efforts of the competition. In fact, in the consumer’s mind, higher prices are most often associated with higher-quality products or services and thus a better price/value relationship. Service Levels/Delivery Format In the foodservice industry, how a product is presented or delivered to customers often affects the customers’ perceptions of value much more than the product itself. Guests are willing to pay more for the same product when service levels are higher. Consumers understand, for example, that a canned soda sold from most vending machines will generally be less expensive than an identical product served in a chilled glass by a friendly waitstaff member. In a similar manner, most guests expect and are quite willing to pay a bit extra for the opportunity to experience a tableside preparation of a Caesar salad or specialty coffee drink. Increasingly, foodservice RMs are assessing their product delivery format when considering pricing. For example, many pizza chains now charge a lower price for a pizza that is picked up and taken away by the guest than for that same pizza eaten inside. Interestingly, however, most QSRs operating drive-throughs still charge their drive-through customers the same price as their dine-in customers. These pricing strategies clearly differ. As an RM, it will ultimately be your job to ensure the strategy used in your organization supports and reinforces the value message you seek to send. Some RMs work in foodservice operations that have not traditionally enjoyed the drivethrough, carry-out, and off-site delivery options available to other RMs. These RMs should still consider the options available for off-site product delivery. Many operators can drum up new and profi table business via the introduction of simple, streamlined, catering programs. Menu items chosen on the basis of their popularity, portability, and profi tability make the most sense. The hospitality industry is a service industry. Thus, as the personal level of service provided increases, prices should also be increased. This personal service may range from the delivery of products, as in the pizza example, to simply increasing the number of servers in a dining room and thus reducing the number of guests each employee must serve. Increased service levels can justify increased prices. This is not to imply that the additional revenues generated should be exclusively reserved to pay for the additional labor. Guests are willing to pay more for increased service levels and the higher prices paid should provide for extra profi ts as well. It is important to recognize that in the foodservice industry those companies that have been able to survive and thrive over the years have done so in large part because of their uncompromising commitment to levels of guest service that exceed those of their competitors, not because of their low price. Guest Type Every type of guest wants value for their money. If you recall the work of economists Milton and Rose Friedman (Chapter 3), however, you recognize that not all guests defi ne value

received in the same way. Understanding the Friedmans’ work is especially important for the restaurant manager. For some guests, price will be critically important. For others guest types, status, image projected, and service levels delivered by the foodservice operation will be far more important. Increasingly, guests are willing to pay for convenience and/or speed. An example of this can clearly be seen in the pricing decisions of convenience stores across the United States. In these facilities, food products such as sandwiches, fruit, drinks, cookies, and the like are sold at relatively high prices. The guests these stores cater to, however, value speed and convenience above all else. For this speed and convenience they are willing to pay a premium price. Other factors are important to other guest types. For example, the couple that goes out for a romantic dinner on a special occasion certainly wants value for their money. The value RM AT WORK 10.2 “The price paid would be the same,” said Braylon. “I know it seems that way, but I still think it’s very different,” replied Lynette. Braylon, the kitchen manager at the Kingsford Steakhouse, was talking to Lynette, the restaurant’s owner. They were discussing the special introductory pricing being developed for a new menu item that would soon be placed on their menu. They were both excited about their chef’s new creation (a beef fi let and lamb chop combination served with a rosemary reduction sauce) and they had agreed it would be priced at $39.95. That was a full fi ve dollars more than their 20-ounce veal chop, the next most expensive item on the Kingsford’s menu. They had decided to implement an introductory pricing strategy for the new item to encourage their regular clientele to give it a try. With its downtown location, USDA Prime beef steaks, and extensive wine list, the Kingsford was a very popular spot for business lunches. At dinner time, it attracted fi ne food enthusiasts from all around the immediate area. “Look,” continued Braylon, “with my idea, we put 50 percent off coupons on our web site. For the new item only. That way, the average selling price is essentially $15.00. With your “buy one/ get the second at no charge,” it’s still 50 percent off. It’s the same.” “But my approach obscures the price reduction better than yours, so I guess I’m not convinced it is the same. Or that our typical guest is the type that clips coupons,” said Lynette. “I don’t know about that,” replied Braylon. “Remember that everybody likes a bargain.” 1. Do you think the guests who would be attracted to Braylon’s pricing strategy are the same type of guests as those that would be attracted to Lynette’s pricing strategy? Why? 2. Do you agree with Braylon that all foodservice guests seek bargains when dining out? 3. Can the distribution method RMs use to advertise a specifi c price affect the profi le of guests who respond to it? Do you see similarities between price distribution strategies in the foodservice industry and the various distribution channels managed by lodging industry RMs? FACTORS AFFECTING VALUE PERCEPTIONS IN FOODSERVICES 375

376 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES they seek, however, may be established much more by the mood and atmosphere experienced in a restaurant than by that restaurant’s prices. The good news for RMs is that many factors that affect different guest types’ view of value are directly subject to management’s control. Product Quality In nearly every instance, a guest’s quality perception of any specifi c product offered for sale in the foodservice business will range from very low to very high. This is not to say that their view of wholesomeness or the safety of the product should vary. These should not. But a guest’s perception of product quality is based on a variety of factors, most of which have little, if anything, to do with the raw ingredient costs of a menu item. For example, when typical foodservice guests think of a hamburger they actually think, not of one product, but a range of products. A hamburger may be correctly envisioned as a less-than-2-ounce burger patty placed on a regular bun, wrapped in paper and served in a sack. If so, its price will likely be low, the service provided with its sale limited, and its perceived quality may be low as well. If, however, a guest’s thoughts turn to an 8-ounce fl ame-charred burger presented with avocado slices and alfalfa sprouts on a toasted wholegrain bun and elegantly served in a white-tablecloth restaurant, the product will be perceived as having higher quality, and if priced properly, deliver higher value. Note that in this example, the price per pound of the burger meat used to make the two alternative products was simply not the determining quality factor. Foodservice managers routinely choose from a range of quality levels when developing product specifi cations and, consequently, planning menus and establishing prices. The product quality you choose is important. For example, if you select the market’s cheapest bourbon as your well brand, you will likely be able to charge less for drinks made from it than your competitor who selects a better brand; but it is not the most important factor in pricing. The cheapest bourbon on the market, beautifully served in a sparkling clean glass, in an exciting atmosphere, by enthusiastic and helpful servers will always be perceived as a superior quality product, and worthy of higher drink prices, than will higher cost bourbon that has been poorly presented. To be successful, RMs must understand how their guests view quality and resist the temptation to oversimplistically equate quality delivered with the price paid for a menu’s raw ingredients. As you have learned, perceived product quality is critical in pricing. Raw ingredient costs are much less critical. Portion Size In a cost-based pricing system, portion size plays a large role in determining menu pricing because size directly affects costs. Portion size can also play a critical role in a value-based differential pricing system. Careful readers will recognize that variations in portion size are simply a form of product versioning (see Chapter 4), a classic differential pricing technique. Product versioning based on portion size, however, is too often applied in the form of bigger is better. That approach leads to increased food costs, increased food waste, and increased customer waists as well. Not good.

Great chefs have always known that guests eat with their eyes fi rst. This relates to presenting food that is visually appealing. It also relates to portion size. A burger and fries that fi ll an 8-inch plate may well be lost on an 11-inch plate. Portion size, then, is a function of both product quantity and presentation. It is in the area of presentation that value perception can be increased with no increase in costs. It is no secret why successful cafeteria chains use smaller than average dishes to plate their food. For their guests, price and value statements come across loud and clear. In some dining situations, particularly in an all-you-care-to-eat operation, the presentation principle again holds true. The proper dish size is just as critical as the proper sized scoop or ladle when serving the food. Increasingly, today’s consumers prefer lighter food with more choices in fruits and vegetables. The portion sizes of these items can be increased at a fairly low increase in cost. At the same time, average sweetened beverage sizes are increasing, as are the size of some side items such as French fries. Again, these tend to be lower-cost items. Within responsible limits and with an eye toward customers’ long-term good health, this can be good news for the foodservice RM if prices can be increased to match the larger sizes. In the very best restaurants, however, giving guests so much food they simple can’t eat it all should not be the goal. Rather, the goal should be the delivery of high-quality food, beautifully presented and served in a manner that maximizes guests’ perceptions of value. Evaluation of portion size and presentation is an excellent example of how RMs can infl uence a foodservice organization’s operational methods. In conjunction with production personnel, every menu item served should be analyzed with an eye toward determining if the quantity being served is the optimum quantity. Just as importantly, each item should be analyzed for its presentation before, not just after, its price is established. Ambiance If people ate out only because they were hungry, few restaurants would be open today. There are certainly lower-cost ways to avoid hunger. In fact, people eat out for a variety of reasons, many of which have very little to do with an operation’s food or its costs. Fun, companionship, time limitations, adventure, and variety are just a few reasons diners cite for eating out rather than eating at home. For the RM whose operation provides an attractive ambiance, menu prices can refl ect this. The operator that provides a pleasing and popular ambiance is selling much more than food and thus will be able to justify increased prices. RMs must recognize, however, that foodservice operations that count on ambiance alone to carry their business generally start out well but are not ultimately successful. Ambiance may draw guests to a location the fi rst time, but excellent product quality and outstanding service go much further over the long run than do overly clever restaurant designs. Interestingly, while many foodservice operators do understand the importance of visual design in establishing ambiance, too few fully understand the role their servers play. The importance of quality servers in the process of creating and maintaining ambience was pointed out well by Starbucks CEO Howard Schultz. When asked in an interview with Essential RM Term Ambiance: The feeling, character, or mood associated with a specifi c location. FACTORS AFFECTING VALUE PERCEPTIONS IN FOODSERVICES 377

378 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES Entrepenuer.com why turnover at his locations was less than a fi fth of that experienced in the typical foodservice operation, Schultz stated: It’s ironic that retailers and restaurants live or die on customer service, yet their employees have some of the lowest pay and worst benefi ts of any industry. That’s one reason so many experiences are mediocre for the public. We pay our partners well at every level, compared to similar positions at other companies.” In 1988, we did something no one else had done, which was to offer our part-time employees comprehensive health care; in 1991, we offered all employees stock options. These benefi ts have paid for themselves in increased productivity and commitment to the business on the part of our partners.15 Starbucks, of course, is not known as the lowest-priced provider of specialty coffee, but it is the most successful. This is due, in large part, to the ambiance created by its facilities and reinforced by its well-trained and well-paid staff. Meal Period In some cases, diners expect to pay more for an item served in the evening than for that same item served at a lunch period. Sometimes this is the result of a smaller luncheon portion size, but in other cases the portion size, as well as service levels, may be exactly the same in the evening as earlier in the day. You must exercise caution in this area. Guests should clearly understand why a menu item’s price changes with the time of day. If this cannot be answered to the guest’s satisfaction, it may not be wise to implement a day part-sensitive pricing structure. Foodservice operators can, however, carefully assess those time periods that currently contribute little or no revenue to their operations. In doing so, they may fi nd that traditionally slow meal periods can be targeted for the development of special menu items or special pricing that can assist in revenue optimization. Because many of a foodservice operation’s costs are fi xed, incremental revenue dollars generated through the extension of nontraditional meal periods (e.g., Taco Bell’s promotion of “fourth meal” is a well-known example16) can be highly profi table dollars. Location Location can be a major factor in determining price. As an RM, you need look no further than America’s many themed amusement parks or sports arenas to see evidence of this. Foodservice operators in these locations are able to charge premium prices because they have, in effect, a monopoly on food sold to the visitors. The only all-night diner on the interstate highway exit is in much the same situation. Contrast that with an operator who is one of ten seafood restaurants on a tourist town’s restaurant row. Essential RM Term Day part: A subsection of the day, during which a specifi c menu type may be served. For example, the time period 6:00 A.M. to 10 A.M. (breakfast) vs. 11:00 A.M. to 2:00 P.M. (lunch). Used to target market and to precisely track sales levels. Essential RM Term Restaurant row: Industry slang for a geographic area that contains multiple and competing foodservice operations.

It used to be said of restaurants that success was due to three things: location, location, and location. This may have been true before so many operations opened in the United States. There is, of course, no discounting the value of a prime restaurant location, and location alone can certainly infl uence pricing decisions. It does not, however, guarantee success. Location can be an asset or a liability. If it is an asset, menu prices may be increased to refl ect the fact that the location itself adds value. If a location is indeed a liability, menu prices may need to be lowered initially in an effort to provide the consumer value needed to attract suffi cient clientele and ensure that the operation’s revenue objectives are met. Image It has always been true that customers do not make a purchase unless they want the thing they are buying more than they want to keep their money. In the foodservice industry, the thing purchased is often much more than food and drink. In many cases, foodservice operations become popular because of the unique image they project. The exclusive nightclub, the trendy bar, and the hard-to-get-into restaurant are just a few examples of facilities RM IN ACTION 10.4: AND FOR DINNER . . . LET’S STOP AT DUNKIN DONUTS! In addition to the revenue optimization potential of differential pricing, a new emphasis on previously neglected meal periods or day parts can provide the opportunity to expand overall sales levels. Money online reported that Dunkin’ Donuts, the coffee and baked goods chain synonymous with breakfast and fresh coffee, had decided to target the afternoon and evening crowds with new fl atbread sandwiches and personal pizzas heated in convection ovens rather than microwaves. Prior to the roll-out, two-thirds of the company’s sales in its 5,400 plus units came before noon, with most customers choosing snacks such as baked goods and breakfast sandwiches with coffee. Addressing his company’s new revenue optimization strategy, Will Kussell, president and chief brand offi cer, was quoted in the article as saying: It speaks to changing consumption trends, with people having a lot more occasions to graze, and consumers’ desire to have what they want, when they want it. Of course it also speaks to the company’s desire to even sales volume among day parts. Interestingly, the company also hopes the new ovens will boost customer satisfaction with breakfast sandwiches (since microwaving can sometimes create limp eggs and mushy bread!) Success is not guaranteed. Nor is it the fi rst time Dunkin’ Donuts has offered non-breakfast items. The chain offered soup and sandwiches in the 1980s with mixed results. The success of McDonald’s in expanding business in its various day parts, Wendy’s struggles in doing the same, and Subway’s entry to the breakfast business, however, provide models of success and of challenge for foodservice RMs whose own operations struggle with uneven sales volume throughout the day. Excerpted on 2/13/2008 from www.money.excite.com. FACTORS AFFECTING VALUE PERCEPTIONS IN FOODSERVICES 379

It is a gross oversimplifi cation to equate formal dining with high-priced dining, or casual dining with lower menu prices. A unique image and the premium prices that can be commanded as a result of it are not the exclusive domain of any one service style. You are likely familiar with Ruth’s Chris Steakhouses, the upscale USDA Prime steakhouse founded by Ruth Fertel in 1965. The product quality, ambiance, and service levels provided allow Ruth’s Chris to charge premium prices and deliver excellent value. Its web site (www.ruthchris.com) refl ects the elegant dining experience provided. You are likely less familiar with the equally pricy but extremely casual Zingerman’s Deli (Ann Arbor, Michigan), where commonly sold items include English farmhouse cedar cheese ($40.00 per pound), Kentucky smoked breakfast sausage ($12.00 per pound), and deli sandwiches at prices approaching those of Manhattan’s most popular 7th Avenue delicatessens. Prices at Zingerman’s refl ect their carefully crafted, laid back image. That image consists of a commitment to providing a wide variety of extremely high-quality food products, exceptional customer service (in a very relaxed atmosphere), and as a result, outstanding value. To view this exceptional operation’s site, go to www.zingermansdeli.com  RM ON THE WEB 10.3 that have captured the imagination of buyers because of the exclusive image they project. The facilities promise their customers that they will feel better about themselves simply because they were able buy. W. Edwards Deming, the American management consultant most famous for his work on quality enhancement, stated this simple fact clearly when he observed: “Profi t in business comes from repeat customers, customers that boast about your product or service, and that bring friends with them.”17 For RMs in foodservice, Deming’s insightful comment holds much meaning because every facility has the opportunity to project a unique image if it fi rst precisely identifi es just what it wants its image to be. Cleanliness, friendliness, speed, décor (and even food!) can be a part of the unique image projected. In addition to these, effective pricing can help demonstrate to guests the desirability of coming and of bringing friends with them. Sales Mix Of all the factors mentioned thus far, sales mix is the one that most tests the abilities of foodservice RMs and is the one that should most heavily infl uence menu pricing decisions. To better understand why, consider again the very different challenges of lodging industry RMs and their food and beverage counterparts. 380 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES

In most cases, the lodging customer chooses from among a fairly limited number of different room types when making a purchase. The number of alternative prices offered to guests is similarly rather limited. In addition, the direct costs associated with providing the alternative room products are fairly similar. For example, the cost of selling a king-bedded room with an ocean view is essentially identical to the cost of providing a king-bedded room with a garden view. This is so despite the fact that the selling price (ADR) associated with these two room types may, due to their location within the hotel, vary quite a bit. The foodservice guest, by contrast, may well have the ability to choose from literally dozens or even hundreds of different menu items resulting in thousands of different meal combinations. The menu mix that will result from guests’ choices is unknown ahead of time, but will dictate an operation’s average sale per guest (check average). Essential RM Terms Menu mix: The total number of various food and beverage products (menu items) ordered by guests during a designated time period. Check average: The mean amount spent per visit by each restaurant guest during a designated time period (e.g., by day part (lunch or dinner) or calendar period (daily, weekly, or monthly). The formula for calculating check average is: Total revenue Guests served 5 Check average Essential RM Term Price blending (foodservice): The process of pricing food and beverage products with different cost ratios in such a way as to optimize revenues in a least cost manner. In most cases, the menu mix produced by guest orders will also directly infl uence total product costs. This is so because not all menu items cost the same to produce or are priced to achieve the same cost-to-selling-price ratio. Astute readers should recognize that, as a result of menu mix, it is the foodservice guest who determines an operation’s average selling price; because of the specifi c menu items he or she selects, as well as the operation product costs, which are also a direct result of the menu mix. Because the number of customers served and menu mix directly determines an operation’s revenue generation and its profi tability, can RMs use strategic pricing to alter an operation’s customer count and menu mix? Absolutely! In fact, the best of foodservice RMs can become especially skilled at price blending. Price blending simply refers to the process of strategically pricing food and beverage products with the intent of optimizing revenue. In many ways it is the equivalent of the lodging RMs’ revenue optimization efforts. The price blending process addresses the fact that the listed price of a menu item will directly affect an item’s popularity and thus the frequency with which that item will be ordered. As you have learned, menu mix is the overall frequency with which different items are ordered and it directly affects an operation’s revenue generation, its resulting product costs, and ultimately its profi tability. FACTORS AFFECTING VALUE PERCEPTIONS IN FOODSERVICES 381

382 CHAPTER 10 REVENUE MANAGEMENT FOR FOOD AND BEVERAGE SERVICES To illustrate the price blending process, assume that you are the operations vice president and newly designated revenue manager for San Diego Red’s, a chain of upscale hamburger restaurants. Assume also that you plan to achieve an overall food cost of 40 percent in your units. For purposes of simplicity, assume that Figure 10.7 illustrates the three products you sell and their corresponding selling price when each is priced to achieve exactly a 40 percent food cost. Recall from earlier in this chapter that the formula for computing a product (food) cost percentage is: Cost of products sold All product sales 5 Product cost % The formula can be worded somewhat differently for a single menu item without changing its accuracy: Cost of a specific item sold Sales of that item 5 Cost % of that item It is important to understand that the sales value indentifi ed in these formulas is synonymous with selling price when assessing the menu price of a single item. For a single menu item the principles of algebra allow you to rearrange the formula as follows: Cost of a specific item sold Cost % of that item 5 Selling price of that item Thus, in Figure 10.7, for example, the hamburger’s selling price is calculated as $1.50 40% 5 $3.75 Note that in Figure 10.7 all products are priced to sell at a menu price that would result in a 40 percent food cost. Under this system, the operation’s sales mix would have no effect on overall food cost percent. The resulting sales mix would, however, likely damage your profi tability. The reason why is very simple. If you use the price structure indicated in Figure 10.7, your drink prices are too low. San Diego Red’s Burgers Item Item Cost Desired Food Cost Proposed Selling Price Hamburger $1.50 40% $3.75 French fries 0.32 40% 0.80 Soft drinks (12 oz.) 0.18 40% 0.45 Total 2.00 40% 5.00 Figure 10.7 Unblended Pricing Structure